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The belt-and-suspenders of the Kennedy-Dodd health care bill

kbh — Thu, 11 Jun 2009 20:34:35 +0000

There is much debate about whether a health care reform bill should include a government-run health insurance plan, a so-called “public option.” Advocates argue that such a plan can compete fairly with private health insurance, and that this competition would “keep insurers honest.” They also argue that more choices are a good thing.

I fall in the other camp. I think that government cannot compete on a level playing field with the private sector. Government always has advantages because of its sovereign power. I also think that in most markets there is a range of private health insurance plans competing for business, and so the addition of one more plan is not worth the downsides of government involvement. (I believe that competition is flawed because for most people their employer shops for health plans. I prefer a system in which individuals are shopping for health plans.)

The government cannot compete on a level playing field with private firms:

Fannie Mae and Freddie Mac had competitive advantages relative to their purely private counterparts. They leveraged those advantages to the gain of their management and shareholders until they collapsed and jeopardized the entire financial system.
Ford Motor Company was not bailed out. It is now disadvantaged relative to GM and Chrysler, which benefited from government oversight, funding, and effective rewriting of bankruptcy rules.
Government-provided terrorism reinsurance is preventing private reinsurance from returning to the marketplace.
Most physician- and hospital-reimbursement structures are based on the methodologies of the largest payor in the market, Medicare.
Government-run direct student loans are now crowding out the guaranteed student loan program, in which private banks and financing firms offer loans. The government advantage comes from control over small details of the program that give direct loans a competitive advantage.

(I would appreciate further examples if commenters have any. Updates are in green.)

The ultimate fear of having a government-run “public” option is that it will crowd out private health insurance, and that ultimately most Americans will be getting their insurance from the government.

At the same time, I hope that opponents of Kennedy-Dodd and the developing House Democrats’ health care bills don’t miss a critical point. Even if the public option is successfully stricken from this legislation, the Kennedy-Dodd goals will be largely achieved by other parts of the bill.

Separate from the Kennedy-Dodd language that creates a new public option, other language in the bill:

Gives a government-appointed Medical Advisory Council the ability to determine a standardized package of minimum benefits;
Establishes three tiers of standardized copayments and deductibles, as well as the total dollar value of benefits included relative to an industry average;
Mandate relative premiums for people with different risk profiles;
Gives the Secretary of Health and Human Services authority to set a maximum percentage of administrative expenditures and profits for health plans;
Requires plans to provide incentives for certain models of delivery of medical care; and
Gives State “Gateways” authority to redistribute resources among health plans to account for the risk distribution of their beneficiaries.

If the government determines benefits, cost-sharing, relative premiums, expenses, and profits, and can take funds from one health plan and give them to another, then the insurance function is governmental.

The ultimate fear of a public option would be immediately implemented by other parts of the Kennedy-Dodd bill. Health plans would turn into a version of Fannie Mae and Freddie Mac: they would have (regulated) private profits but public purposes. (A friend points out that the Fannie/Freddie comparison doesn’t work well here. F/F are more about “private profit but public risk.”)

This is a smart tactical move by the authors of the bill. They have a belt (the public option) and suspenders (government control of private insurance). They achieve their policy goal even if they lose the public option.

Killing the public option is essential, but it isn’t enough to prevent government-run health care.

The belt-and-suspenders of the Kennedy-Dodd health care bill

© 2010 Keith Hennessey - Your guide to American economic policy

Ten more things about the official Kennedy-Dodd health care bill

kbh — Wed, 10 Jun 2009 23:05:00 +0000

The Senate HELP Committee staff has filed an official copy of their draft legislation with the Senate clerk. A friend and I were discussing today two possible tactical scenarios:

The weekend leak forced the majority staff to release their official text as damage control. Under this scenario, filing the official copy is a damage mitigation strategy: “If there’s going to be a version out there, let’s at least have it be a version we want.”
The weekend leak was by the majority staff, and filing the official text is part of a gradual rollout strategy.

I’m guessing scenario 1 is right. Either way, we now have official text to chew on. This text is more expansive than the leaked version I posted Monday. It contains some new items, but is largely identical to the leaked draft.

More importantly, I have now had more time to read the 615 page bill. (I skimmed some parts.) Doing so turned up some things I missed the first time. So here are ten more things you should know about the official draft of the Kennedy-Dodd health care bill.

(Editorial note: I have made a page that will always have the latest version of this complete list, along with the comparison to the House Democrats’ bill. I will also post when I update that page.)

The employer mandate section from the leaked draft has been replaced with “[Policy under discussion]”.

A few inside friends confirmed my guess – they think this is a tactical move by the majority staff to try to relieve blowback from the employer groups: Chamber of Commerce, Business Roundtable, NFIB (the small business lobby), etc. Until it is otherwise demonstrated, I will continue to assume that the Chairman’s mark will include language that will roughly parallel that in the leaked draft.
The bill gives the Secretary of Health and Human Services authority to limit premiums and profits of health plans by forcing plans to rebate to enrollees premiums above a certain margin.
Specifically, §2704(a) is the “Requirement to provide value for premium payments.” A health plan must report how much of their premium revenues are used for clinical services, how much for “activities that improve health care quality,” and how much for “all other non-claims costs.”

§2704(b)(1) then tells the Secretary to look at how much other health plans spent on “all other non-claims costs,” and based on that survey, set an allowable percentage for this category. Plans are then required to rebate premiums if they go above this amount. This is direct (but confusing) regulation of premiums and profit margins.

I found the labeling of this section interesting. It appears that this section will be the justification for the claim that this bill reduces health care costs. Loosely phrased, it appears their argument will be “We’re reducing health care costs by forcing plans to lower their administrative costs and profits.”
The bill mandates that health plans include and provide financial incentives for the “medical home model” for services, then gives a highly prescriptive description of this model, detailing the interactions among the health plan and different types of providers.

§3101(m) requires qualified health plans to develop and adopt a strategy “that provides increased reimbursement or other incentives for … improving health outcomes … including through the use of the medical home model defined in section 212 [of the] Affordable Health Choices Act, for treatment or services under the plan or coverage;”

§212 then sets up the “medical home model” over seven pages of legislative text. I am far from an expert in plan-provider relationships, and am not familiar with the medical home model. But the language looks highly prescriptive, as if it is defining an extensive set of rules about the interactions among plans and different types of providers. I would love help from some commenters on what’s going on here, or some more education about the “medical home model.” My instinct is that, even if it is a good delivery model, the federal government should not be tilting the playing field for or against it.
The bill requires health plans adopt Medicare and SCHIP’s “generally implemented incentive policy to promote high quality health care.”
Employers must offer the same health insurance to all employees, independent of salary.
Gateways can charge a tax of up to 3% of premiums to cover implementation and administrative costs.This is a huge deal. Take a typical $13,000 (employer-based) family health insurance policy. That means the State can add up to $390/year to the cost.
The Secretary of Health and Human Services shall required that Gateways shall “ensure that [uninsured] individuals are directed to enroll in the program [that she deems] most appropriate.” This is in the context of whether they should enroll in a private health plan, or a government plan: Medicaid, SCHIP, or the new “public option.” The bill gives SecHHS authority to push/force State Gateways to push/encourage/force? the uninsured toward (or away from) particular types of plans. The danger is that a SecHHS could say, “It’s best to have all the uninsured in a government plan.”
States (through Gateways) shall redistribute premiums from plans with low-risk individuals to those with high-risk individuals.

This gives the people running Gateways a tremendous amount of power over health plans.
States can opt out their state and local employee plans for the first four years. I’m trying to think of a reason why they should be treated differently. Otherwise, it looks like caving to pressure either from State governments, or from public employee unions.
The bill creates a new $10 B “Reinsurance for Retirees” fund to subsidize costs for those between ages 55 and 64. The bill defines eligible “employers” to include “a voluntary employee benefit association.” This may include the UAW VEBA.

This looks like a fallback. Traditionally, health advocates on the Left have wanted to allow near-retirees (55-64) to “buy in early” to Medicare. And I need to be clear – I cannot conclude that this provision was written specifically to benefit the UAW VEBA. I just know that it allows a VEBA to apply as an employer for a share of this fund, and that the UAW VEBA is the most prominent one that might ask for such funds.

Remember, you can now always find an updated version of the complete list here.

While the list of two dozen items surely creates an impression of why I oppose this bill, I would like to put some structure on it. I hope to post in the next few days a higher-level view that crystallizes my biggest concerns with this bill in a structure that is easier to understand.

(photo credit: Wikipedia)

Ten more things about the official Kennedy-Dodd health care bill

© 2010 Keith Hennessey - Your guide to American economic policy

Understanding the Kennedy-Dodd and House Democrats’ health care bills

kbh — Wed, 10 Jun 2009 22:32:55 +0000

This page contains the most recent version of my list of “things you should know about the Kennedy-Dodd health care bill,” interspersed with parallel observations about the leaked outline of the House Democrats’ health care bill.

I will post each time I update this page, so you can track it incrementally. If you bookmark this page, you can always get the latest version.

For reference, here is the official text of the Kennedy-Dodd health care bill, as filed with the Senate clerk. And here is the leaked outline of the House Democrats’ health care bill.

Here are two dozen things you should know about the Kennedy-Dodd bill and the House bill outline.

The Kennedy-Dodd bill would create an individual mandate requiring you to buy a “qualified” health insurance plan, as defined by the government. If you don’t have “qualified” health insurance for a given month, you will pay a new Federal tax. Incredibly, the amount and structure of this new tax is left to the discretion of the Secretaries of Treasury and Health and Human Services (HHS), whose only guidance is “to establish the minimum practicable amount that can accomplish the goal of enhancing participation in qualifying coverage (as so defined).” The new Medical Advisory Council (see #3D) could exempt classes of people from this new tax. To avoid this tax, you would have to report your health insurance information for each month of the prior year to the Secretary of HHS, along with “any such other information as the Secretary may prescribe.”
The House bill also contains an individual mandate. The outline is less specific but parallel: “Once market reforms and affordability credits are in effect to ensure access and affordability, individuals are responsible for having health insurance with an exception in cases of hardship.”
The official draft of Kennedy-Dodd says “Policy under discussion” for this section. I surmise that’s a tactical move on the part of the committee staff to try to lessen blowback from employer groups. In the leaked draft, which I will guess is still their actual intent, the Kennedy-Dodd bill would also create an employer mandate. Employers would have to offer insurance to their employees. Employers would have to pay at least a certain percentage (TBD) of the premium, and at least a certain dollar amount (TBD). Any employer that did not would pay a new tax. Again, the amount and structure of the tax is left to the discretion of the Secretaries of Treasury and HHS. Small employers (TBD) would be exempt.
The House bill outline also contains an employer mandate that appears to parallel that in Kennedy-Dodd: “Employers choose between providing coverage for their workers or contributing funds on behalf of their uncovered workers.”
In the Kennedy-Dodd bill, the government would define a qualified plan:
1. All health insurance would be required to have guaranteed issue and renewal, modified community rating, no exclusions for pre-existing conditions, no lifetime or annual limits on benefits, and family policies would have to cover “children” up to age 26.
  The House bill outline is consistent with but less specific than the Kennedy-Dodd legislative language. The House bill outline would “prohibit insurers from excluding pre-existing conditions or engaging in other discriminatory practices.” I will keep my eye on what “other discriminatory practices” means in the legislative language. Does that mean that a health plan cannot charge higher premiums to smokers?
  
  Like the Kennedy/Dodd bill, the House bill outline would preclude health plans from imposing lifetime or annual limits on benefits: “Caps total out-of-pocket spending in all new policies to prevent bankruptcies from medical expenses.” This would raise premiums for new policies.
  
  The House bill outline “introduces administrative simplification and standardization to reduce administrative costs across all plans and providers.” I don’t know what this means, but suggest keeping an eye on it.
2. A qualified plan would have to meet one of three levels of standardized cost-sharing defined by the government, “gold, silver, and bronze.” Details TBD.
  Same: “… by creating various levels of standardized benefits and cost-sharing arrangements…”. It also contains this addition relative to Kennedy-Dodd: “… with additional benefits available in higher-cost plans.”
  
  But note the “various levels of standardized benefits.” This appears to be more expansive government control of health plan design than in the Kennedy-Dodd draft.
3. Plans would be required to cover a list of preventive services approved by the Federal government.
  This is unspecified in the House bill outline. We’ll have to wait to see legislative language. The House bill would require plans to “waive cost-sharing for preventive services in benefit packages.”
4. A qualified plan would have to cover “essential health benefits,” as defined by a new Medical Advisory Council (MAC), appointed by the Secretary of Health and Human Services. The MAC would determine what items and services are “essential benefits.” The MAC would have to include items and services in at least the following categories: ambulatory patient services, emergency services, hospitalization, maternity and new born care, medical and surgical, mental health, prescription drugs, rehab and lab services, preventive/wellness services, pediatric services, and anything else the MAC thought appropriate.
  This appears parallel but is less specific for now: “Independent public/private advisory committee recommends benefit packages based on standards set in statute.” I find the “standards set in statute” interesting. It suggests that provider and disease interest groups will have two fora in which to lobby for their benefits to be mandated: Congress, and the advisory committee.
5. The MAC would also define what “affordable and available coverage” is for different income levels, affecting who has to pay the tax if they don’t buy health insurance. The MAC’s rules would go into effect unless Congress passed a joint resolution (under a fast-track process) to turn them off.
  The House bill outline is silent on this.
Health insurance plans could not charge higher premiums for risky behaviors: “Such rate shall not vary by health status-related factors, … or any other factor not described in paragraph (1).” Smokers, drinkers, drug users, and those in terrible physical shape would all have their premiums subsidized by the healthy.
The House bill outline says it would “prohibit plans [from] rating (charging higher premiums) based on gender, health status, or occupation and strictly limits premium variation based on age.” If the bill were to provide nothing more, this would appear to parallel the Senate bill and preclude plans from charging higher premiums for risky behaviors.
Guaranteed issue and renewal combined with modified community rating would dramatically increase premiums for the overwhelming majority of those Americans who now have private health insurance. New Jersey is the best example of health insurance mandates gone wild. In the name of protecting their citizens, premiums are extremely high to cover the cross-subsidization of those who are uninsurable.
The House bill outline is silent on guaranteed issue and renewal. I’m going to make an educated guess that the bill includes these provisions as part of “other discriminatory practices,” and they have just left them out of the outline. Given the philosophy behind this outline (with which I disagree), it would be a striking omission. But for now, the outline says nothing specific on these topics.
The bill would expand Medicaid to cover everyone up to 150% of poverty, with the Federal government paying all incremental costs (no State share). This means adding childless adults with income below 150% of the poverty line.
The House bill outline “expands Medicaid for the most vulnerable, low-income populations,” so we have no specifics other than that there’s an expansion. I cannot tell if this is expanding eligibility or benefits. The outline also “improves payment rates to enhance access to primary care under Medicaid.” I assume this means the bill would expand the Federal share paid of each dollar spent by a State Medicaid program on primary care, rather than the Federal government actually mandating specific payment rates to be implemented by States. Federal micromanagement of specific Medicaid provider payment rates was eliminated in the mid 1990’s.
People from 150% of poverty up to 500% (!!) would get their health insurance subsidized (on a sliding scale). If this were in effect in 2009, a family of four with income of $110,000 would get a small subsidy. The bill does not indicate the source of funds to finance these subsidies.
The House bill outline has a sliding scale up to 400% of poverty. If this were in effect in 2009, a family of four with income of $88,000 would get small subsidy.
People in high cost areas (e.g., New York City, Boston, South Florida, Chicago, Los Angeles) would get much bigger subsidies than those in low cost areas (e.g., much of the rest of the country, especially in rural areas). The subsidies are calculated as a percentage of the “reference premium,” which is determined based on the cost of plans sold in that particular geographic area.
The House bill outline is not specific on this point. I would not expect it to be – this is something you can tell only from legislative language.
There would be a “public plan option” of health insurance offered by the federal government. In this new government health plan, the federal government would pay health care providers Medicare rates + 10%. The +10% is clearly intended to attract short-term legislative support from medical providers. I hope they are not so naive that they think that differential would last.
The House bill outline “creates a new public health insurance within the Exchange … the public health insurance option competes on ‘level field’ with private insurers in the Exchange.” There are no specifics on how the public plan would work, or on provider payment rates.
Group health plans with 250 or fewer members would be prohibited from self-insuring. ERISA would only be for big businesses.
The House bill outline is silent on this point.
States would have to set up “gateways” (health insurance exchanges) to market only qualified health insurance plans. If they don’t, the Feds will set up a gateway for them.
The House calls it an Exchange rather than a Gateway. While the Senate bill would tell each State, “Create a Gateway or we’ll create one for you,” the House bill outline says to each State, “We’re creating a single new national Exchange. You’re in it unless you develop your own State or Regional Exchange.”
Health insurance plans in existence before the law would not have to meet the new insurance standards. This creates a weird bifurcated system and means you would (probably) be subject to a different set of rules when you change jobs.
The House bill outline appears to parallel the Kennedy-Dodd draft: “Phases-in requirements to benefit and quality standards for employer plans.” This means that new plans will be more expensive than old plans. It also means they’re creating a bifurcated system with all sorts of perverse unintended consequences for employment flexibility.
The bill does not specify what spending will be cut or what taxes will be raised to pay for the increased spending. That is presumably for the Finance Committee to determine, since it’s their jurisdiction.
The House bill outline lists specific topics for changes to Medicare reimbursement:
- Changing (how?) the Medicare reimbursement for doctors, called the “Sustainable Growth Rate” (SGR).
- “Increasing reimbursement for primary care providers”
- “Improving” the Medicare drug program. I won’t be surprised if, when I see the specifics, I disagree that their changes are “improvements.” In the past this has meant having the federal government mandate specific prices for drugs.
- Cutting payments to Medicare Advantage plans.
- Expanding low-income subsidies for seniors and eliminating cost-sharing for all preventive services in Medicare.
The House bill outline also uses positive language to describe things that might generate budgetary savings from Medicare and/or Medicaid. The hospital readmissions point is specific. The first two points could increase or decrease federal spending, depending on the specifics.
- “Use federal health programs … to reward high quality, efficient care, and reduce disparities.”
- “Adopt innovative payment approaches and promote[s] better coordinated care in Medicare and the new public option through programs such as accountable care organizations.”
- “Attack the high rate of cost growth to generate savings for reform and fiscal sustainability, including a program in Medicare to reduce preventable hospital readmissions.”

The bill defines an “eligible individual” as “a citizen or national of the United States or an alien lawfully admitted to the United States for permanent residence or an alien lawfully present in the United States.”
The House bill outline is silent on this point, and for all other items listed below.
The bill would create a new pot of money for state gateways to pay “navigators” to educate people about the new bill, distribute information about health plans, and help people enroll. Navigators receiving federal funds “may include … unions, …”
The bill gives the Secretary of Health and Human Services authority to limit premiums and profits of health plans by forcing plans to rebate to enrollees premiums above a certain margin.

Specifically, §2704(a) is the “Requirement to provide value for premium payments.” A health plan must report how much of their premium revenues are used for clinical services, how much for “activities that improve health care quality,” and how much for “all other non-claims costs.”
§2704(b)(1) then tells the Secretary to look at how much other health plans spent on “all other non-claims costs,” and based on that survey, set an allowable percentage for this category. Plans are then required to rebate premiums if they go above this amount. This is direct (but confusing) regulation of premiums and profit margins.

I found the labeling of this section interesting. It appears that this section will be the justification for the claim that this bill reduces health care costs. Loosely phrased, it appears their argument will be “We’re reducing health care costs by forcing plans to lower their administrative costs and profits.”
The bill mandates that health plans include and provide financial incentives for the “medical home model” for services, then gives a highly prescriptive description of this model, detailing the interactions among the health plan and different types of providers.
§3101(m) requires qualified health plans to develop and adopt a strategy “that provides increased reimbursement or other incentives for … improving health outcomes … including through the use of the medical home model defined in section 212 [of the] Affordable Health Choices Act, for treatment or services under the plan or coverage;”

§212 then sets up the “medical home model” over seven pages of legislative text. I am far from an expert in plan-provider relationships, and am not familiar with the medical home model. But the language looks highly prescriptive, as if it is defining an extensive set of rules about the interactions among plans and different types of providers. I would love help from some commenters on what’s going on here, or some more education about the “medical home model.” My instinct is that, even if it is a good delivery model, the federal government should not be tilting the playing field for or against it.
The bill requires health plans adopt Medicare and SCHIP’s “generally implemented incentive policy to promote high quality health care.”

Employers must offer the same health insurance to all employees, independent of salary.

Gateways can charge a tax of up to 3% of premiums to cover implementation and administrative costs.
This is a huge deal. Take a typical $13,000 (employer-based) family health insurance policy. That means the State can add up to $390/year to the cost.
The Secretary of Health and Human Services shall required that Gateways shall “ensure that [uninsured] individuals are directed to enroll in the program [that she deems] most appropriate.”
This is in the context of whether they should enroll in a private health plan, or a government plan: Medicaid, SCHIP, or the new “public option.” The bill gives SecHHS authority to push/force State Gateways to push/encourage/force? the uninsured toward (or away from) particular types of plans. The danger is that a SecHHS could say, “It’s best to have all the uninsured in a government plan.”
States (through Gateways) shall redistribute premiums from plans with low-risk individuals to those with high-risk individuals.
This gives the people running Gateways a tremendous amount of power over health plans.
States can opt out their state and local employee plans for the first four years.
I’m trying to think of a reason why they should be treated differently. Otherwise, it looks like caving to pressure either from State governments, or from public employee unions.
The bill creates a new $10 B “Reinsurance for Retirees” fund to subsidize costs for those between ages 55 and 64. The bill defines eligible “employers” to include “a voluntary employee benefit association.” This may include the UAW VEBA.
This looks like a fallback. Traditionally, health advocates on the Left have wanted to allow near-retirees (55-64) to “buy in early” to Medicare. And I need to be clear – I cannot conclude that this provision was written specifically to benefit the UAW VEBA. I just know that it allows a VEBA to apply as an employer for a share of this fund, and that the UAW VEBA is the most prominent one that might ask for such funds.

These bills would have severe effects on the more than 100 million Americans who have private health insurance today:

The government would mandate not only that you must buy health insurance, but what health insurance counts as “qualifying.”
Health insurance premiums would rise as a result of the law, meaning lower wages.
A government-appointed board would determine what items and services are “essential benefits” that your qualifying plan must cover.
You would find a tremendous new disincentive to switch jobs, because your new health insurance may be subject to the new rules and would therefore be significantly more expensive.
Those who keep themselves healthy would be subsidizing premiums for those with risky or unhealthy behaviors.
Far more than half of all Americans would be eligible for subsidies, but we have not yet been told who would pay the bill.
The Secretaries of Treasury and HHS would have unlimited discretion to impose new taxes on individuals and employers who do not comply with the new mandates. (The House bill outline is not specific on this point.)
The Secretary of HHS could mandate that you provide him or her with “any such other information as [he/she] may prescribe.” (The House bill outline is not specific on this point.)

I strongly oppose the Kennedy-Dodd bill and the House Tri-Committee bill.

Understanding the Kennedy-Dodd and House Democrats’ health care bills

© 2010 Keith Hennessey - Your guide to American economic policy

Government Motors discussion on Fox News Sunday (continued)

kbh — Sun, 07 Jun 2009 18:41:21 +0000

In an earlier post I attempted to correct Dr. Austan Goolsbee’s incorrect and inflammatory statements about President Bush. I would like here to add my views to one additional question on the auto industry discussion on this morning’s edition of Fox News Sunday.

Host Chris Wallace moderated a discussion this morning with:

Dr. Austan Goolsbee, Member of President Obama’s Council of Economic Advisers and chief economist on the President’s Economic Recovery Advisory Board;
Senator Richard Shelby (R-AL), ranking Republican on the Senate Banking Committee;
Thayer Capital Chairman Fred Malek; and
Google CEO Eric Schmidt.

I offer kudos to Mr. Schmitt for his thoughtful responses throughout. And the hero of the discussion was Mr. Wallace, who in his questions demonstrated a deep understanding of the actual options faced by policymakers, the choices they made, and the serious consequences of those choices. I thank him for trying to elevate the policy discussion this morning.

Here’s Chris Wallace asking Fred Malek whether the Bush Administration have provided loans before a Chapter 11 filing:

WALLACE: Let me bring in Fred Malek, though. The President says that he has no interest in running businesses, he’s just trying to save them from collapse and get out. [plays clip of President Obama's press conference] Fred Malek, in the middle of a financial crisis, in the middle of a terrible recession, could the President really let General Motors and Chrysler, AIG and Citibank go under?

MALEK: … I think what you have here, is you have two different situations. I would label the injection of capital into the financial institutions, stabilizing the financial systems, that’s a war of necessity. You had to do that. But, getting into General Motors, saving General Motors and then taking them into bankruptcy, that’s a war of choice, it’s the wrong choice.

Senator Shelby later commented on this same question, as did Mr. Malek again:

SHELBY: First of all, I advocated last fall that General Motors and Chrysler’s best bet would have go to Chapter 11 then, it would have saved a lot of money, not a political restructuring like what’s happened, where the bondholders have been sacrificed, the unions have carried the day. …

MALEK: … I agree with Senator Shelby. Look, we’ve had for decades we’ve had a bankruptcy system in this country that has worked well, and has fueled the free enterprise system in a positive way. It is impervious to politics because it’s run by federal courts. Now, what have you done? You have taken it out of the judicial and you’ve turned it over to the executive, and I think you’ve injected politics into it. Senator Shelby is right, there was no sense in putting billions of dollars in and then declaring Chapter 11 afterwards. They should have let them go into bankruptcy and let the courts work it through. …

Mr. Wallace then asks the critical follow-up question:

WALLACE: Let me just ask. Mr. Goolsbee, if at some point, either the Bush Administration back in the fall, or you guys when you took over, had just said, go into Chapter 11, we’re not going to take an ownership stake, we’re not going to give you 50 billion dollars, what would have happened?

The answer is that GM and Chrysler would have liquidated. Neither GM nor Chrysler was ready for a complex Chapter 11 filing. Had the entered the Chapter 11 process in December or January, the firms and every outside expert told us that the restructuring would have failed and the firms would have liquidated. We estimated this would have resulted in about 1.1 million lost jobs.

Mr. Malek was right, the loans to GM and Chrysler were a choice, but they were not the choice that he and Senator Shelby thought we faced. The choice was loan or liquidate. There was no feasible Chapter 11 option available at the time. (GM may fail even now, after they have had five months to prepare for Chapter 11.) Mr. Schmitt frames it correctly:

SCHMITT: It seems to me that what choice did we have except try to save General Motors, given the roughly million jobs that were related at a time of incredible pain and job loss. So if you think about it , the choice was bankruptcy, the supply chain goes away, the loss of the American automobile industry, or a band-aid. It needs to be a band-aid, and it needs to be something we get out of. …

Government Motors discussion on Fox News Sunday (continued)

© 2010 Keith Hennessey - Your guide to American economic policy

Dr. Goolsbee gets it wrong on the auto loans

kbh — Sun, 07 Jun 2009 18:26:09 +0000

This morning on Fox News Sunday, host Chris Wallace moderated a discussion about the auto industry. One of his guests was Dr. Austan Goolsbee, who is a Member of President Obama’s Council of Economic Advisers and chief economist on the President’s Economic Recovery Advisory Board.

I want to focus on some incorrect and inflammatory statements by Dr. Goolsbee this morning:

Chris Wallace: I also want you to talk about the clash between policy and profits. The governments wants General Motors to make small cars, fuel-efficient cars, while all the indications are, that according to the market, the cars they make most profit on are SUVs and pickup trucks. So which takes preference? Profits for the taxpayer shareholders, or environmental policy?

Dr. Goolsbee: The President made totally clear in his remarks, and he specifically said we are not going to be in the business of telling General Motors or anybody else what kind of cars to make, where they should open their plants, or anything of the sort. The President made clear we want to get out of this as quickly as possible. We are only in this situation because somebody else kicked the can down the road, and that’s really an understatement. They shook up the can, they opened the can, and handed to us in our laps. Senator Shelby knows that to be true. When George Bush put money in to General Motors, almost explicitly with the purpose, how many dollars do they need to stay alive until January 20th, 2009? There was no commitment to restructuring, to making these viable enterprises of any kind. They made none of the serious sacrifices. And Republicans in the Senate attached a list of conditions, they opposed George Bush’s intervention, because they said the unions had not made the following sacrifices. In the Obama plan, it asked more and received more from the unions and from the other stakeholders than the people that objected to the bailout last November asked for. So we have finally put them on that path.

This is incorrect. I will bite my lip, refrain from commenting on the tone, and focus on the facts.

History

At 3:30 pm on Sunday, November 30, 2008, a quiet meeting occurred at the Treasury Department in Secretary Hank Paulson’s office. Present for the Bush Administration were Treasury Secretary Paulson and Commerce Secretary Carlos Gutierrez, White House Chief of Staff Josh Bolten, Deputy COS Joel Kaplan, White House Legislative Affairs chief Dan Meyer, Treasury Legislative Affairs head Kevin Fromer, and me. Present for the incoming Obama Administration were Deputy COS-designate Mona Sutphen, NEC-designate Dr. Larry Summers, Dan Turullo (now a Fed Governor), and WH Legislative Affairs-designate Phil Schiliro. We had requested the meeting. They agreed and asked that it be held outside the White House. It appeared to us that they were quite concerned about leaks, and about the risk of creating a public impression that they were working closely with us.

At that meeting, we (the Bush team) floated a proposal to establish an auto czar. President Bush would create a new position called a Financial Viability Advisor (FVA) through an executive order. The President would instruct the FVA, for any auto manufacturer that sought a “bridge loan,” to evaluate that firm’s restructuring plan for viability. If after 60 days (which the FVA could unilaterally extend for another 30) the firm did not have a plan to achieve viability, then the FVA would produce his own plan to make that firm viable. The draft executive order was explicit that the FVA could include a Chapter 11 bankruptcy in his plan. We invited the Obama team to suggest names for the Financial Viability Advisor, so that it would be someone with whom the new President would be comfortable.

Under the Bush team’s proposal to the Obama team, the current Secretary of the Treasury (Paulson) would provide bridge funding from the TARP, and he would state that, as a matter of policy, no further TARP funding would be made available except in support of (1) a plan certified as viable by the FVA, or (2) the FVA’s own plan.

The key to success of this plan was that the Obama team would publicly link arms with us and agree that they would continue the Paulson policy statement when they took over after January 20th. Thus, the auto company’s stakeholders would know that they had no wiggle room, and that they had no chance of getting additional funding from the next Administration. The Obama team would voluntarily commit itself to be bound by the restriction self-imposed by the Bush team.

Remember that this was one of two huge issues going on at the time. The bigger issue was the financial crisis, and we were nearing the limit on the $350 B of available TARP funds. We were concerned that another too-big-to-fail institution might fail before January 20th without Treasury having the funds available to prevent a systemic collapse. So our proposal to the Obama team was a package deal: we will announce the above process for autos, and we will ask Congress for the second $350 B of TARP funding, if the President-elect publicly supports us on both. They would join with us in convincing Congress to approve the last tranche of TARP funding, since we would need help with Congressional Democrats.

We saw two huge economic issues that posed grave risks to the economy and to a smooth transition. We proposed to work together with the incoming Administration in a way that we thought minimized these risks and would have positioned the new President as well as possible on January 20th. GM and Chrysler would not be in liquidation, and there would be a strict, tight, and enforceable deadline (of about March 1) and process for GM and Chrysler to become viable or to have time to prepare for an orderly Chapter 11 process. We would have a cushion in case another major financial institution failed in the last eight weeks, and the next President would not have to be bothered with having to ask Congress for the last $350 B from the TARP.

The Obama team were polite and professional. They listened carefully and gave little reaction in the meeting. We concluded based on their questions in that meeting that they were leaning against the proposal, because they did not want to be bound by the judgment of a Financial Viability Advisor – they wanted the ability to make decisions in the White House. They also appeared to want to avoid being bound by our strict definition of viability. (We defined a viable firm as one that would, under reasonable assumptions, have a positive net present value without additional taxpayer assistance.)

Dr. Goolsbee was not in this meeting. I do not know if he was aware of it, either back in November or this morning.

Despite multiple efforts to get the Obama team on board, they did not take up our proposal, nor did they suggest any modifications. At the end of that week we gave up on that approach and began to negotiate a bill with Speaker Pelosi, Chairman Barney Frank, and Chairman Chris Dodd that would provide bridge loans from previously appropriated non-TARP funds. Senate Republicans blocked that bill. Congress adjourned for the year and went home. In the last week of December, GM and Chrysler told us they would file under Chapter 11 in early January if they did not get loans from the TARP. They also told us, as did countless outside experts, that they were not ready for such a filing, and that Chapter 11 would lead to near-immediate liquidation. We estimated that about 1.1 million jobs would be lost if this happened.

Confronted with a choice between loaning TARP funds to GM and Chrysler, and allowing both to liquidate in the weeks before his successor took office, President Bush authorized loans from the TARP to GM and Chrysler. We had warned Senate Republicans earlier that month that the President would face this choice if legislation failed. This was (and still is) a politically unpopular decision, and was the least worst of two bad options. Based both on his public comments and what I saw privately, President Bush wanted to give the firms a limited amount of time and a hard back end to prepare for and, if necessary, to force an orderly Chapter 11 process. He also knew that President-elect Obama would be facing tremendous challenges in his first days in office. Despite their different political parties and policy perspectives, President Bush stressed that we needed to provide his successor with the time and space he would need in the opening weeks of his Presidency.

Structure of the December loans to GM and Chrysler

In the last few days of December, Treasury loaned $24.9 B from TARP to GM, Chrysler, and their financing companies.

According to the terms of the loan (see pages 5-6 of the GM term sheet), by February 17th GM and Chrysler would have to submit restructuring plans to the President’s designee (and they did).

Each plan had to “achieve and sustain the long-term viability, international competitiveness and energy efficiency of the Company and its subsidiaries.” Each plan also had to “include specific actions intended” to achieve five goals. These goals came from the legislation we negotiated with Frank, Pelosi, and Dodd:

repay the loan and any other government financing;
comply with fuel efficiency and emissions requirements and commence domestic manufacturing of advanced technology vehicles;
achieve a positive net present value, using reasonable assumptions and taking into account all existing and projected future costs, including repayment of the Loan Amount and any other financing extended by the Government;
rationalize costs, capitalization, and capacity with respect to the manufacturing workforce, suppliers and dealerships; and
have a product mix and cost structure that is competitive in the U.S.

The Bush-era loans also set non-binding targets for the companies. There was no penalty if the companies developing plans missed these targets, but if they did, they had to explain why they thought they could still be viable. We took the targets from Senator Corker’s floor amendment earlier in the month:

reduce your outstanding unsecured public debt by at least 2/3 through conversion into equity;
reduce total compensation paid to U.S. workers so that by 12/31/09 the average per hour per person amount is competitive with workers in the transplant factories;
eliminate the jobs bank;
develop work rules that are competitive with the transplants by 12/31/09; and
convert at least half of GM’s obliged payments to the VEBA to equity.

If, by March 31, the firm did not have a viability plan approved by the President’s designee, then the loan would be automatically called. Presumably the firm would then run out of cash within a few weeks and would enter a Chapter 11 process. We gave the President’s designee the authority to extend this process for 30 days.

In another error this morning, Dr. Goolsbee claimed the “Obama plan, it asked more and received more from the unions and from the other stakeholders than the people that objected to the bailout last November asked for.” As I wrote last Monday (Understanding the GM bankruptcy), I have seen no convincing evidence that GM workers will now be paid competitive compensation with transplant workers, nor that the work rules are competitive with the transplants. The negotiations led by the Obama team did meet the Corker targets for the unsecured debt holders and the retiree benefits, but current workers still look to have received a relatively good deal.

Chronology

November 30: Bush team proposes joint solution to Obama team.

The following week: Obama team declines to respond. Bush team begins negotiations with House and Senate Democrats.

Mid-December: Bush team negotiates compromise legislation with House and Senate Democrats. Senate Republicans block the legislation. Congress goes home.

Late December: President Bush authorizes the above-described three month loans to GM and Chrysler.

January 20: President Obama takes office.

Mid-February: GM and Chrysler submit their first viability plans, per the terms of the Bush-era loans.

End of March: President Obama says GM and Chrysler have failed to develop viable plans, as required by the Bush-era loans. He gives Chrysler 30 more days, and GM about 60 until the end of May.

End of April: Chrysler files Chapter 11 with a pre-packaged plan negotiated largely by the Obama Administration.

June 1: GM does the same. Chrysler emerges from Chapter 11.

Responding to Dr. Goolsbee

Let’s again examine Dr. Goolsbee’s claim:

We are only in this situation because somebody else kicked the can down the road, and that’s really an understatement. They shook up the can, they opened the can, and handed to us in our laps. Senator Shelby knows that to be true. When George Bush put money in to General Motors, almost explicitly with the purpose, how many dollars do they need to stay alive until January 20th, 2009? There was no commitment to restructuring, to making these viable enterprises of any kind. They made none of the serious sacrifices.

Even if Dr. Goolsbee was not privy to the quiet discussion we had with the senior Obama team last November, the public record refutes his claim:

The Obama team declined to respond to the Bush team’s offer to work together to create a joint process that would have resulted in a resolution by March 1st or April 1st, rather than by June 1st for Chrysler and maybe September 1st for GM.
We then worked with the Democratic majority to enact legislation that would have limited funds to be available only to firms that would become viable.
After Congress left town for the holidays without having addressed the issue, President Bush was faced with a choice between providing loans and allowing these firms to liquidate in early January, which would have further exacerbated the economic situation for the incoming President. President Bush chose to provide the loans.
We provided GM and Chrysler with sufficient funds to get to March 31st, not January 20th, and in those loans we gave the incoming Administration the ability to extend them for 30 more days.
The loans were conditioned on restructuring to become viable, with a precise definition of viability, specific restructuring goals, and quantitative targets.
The Obama Administration followed the restructuring process laid out in the Bush-era loans. They are now measuring that deal against the targets established in the Bush-era loans. The only changes the Obama team made were that they extended GM for 60 days rather than 30, and the Obama Administration directly inserted themselves into the negotiations as the pre-packager.

Dr. Goolsbee’s comments this morning were both inflammatory and incorrect.

Dr. Goolsbee gets it wrong on the auto loans

© 2010 Keith Hennessey - Your guide to American economic policy

Understanding the GM bankruptcy

kbh — Mon, 01 Jun 2009 23:17:03 +0000

Many of you are new to this blog since I wrote extensively about autos six weeks ago. As background, I coordinated the auto loan process for President Bush last fall as the Director of the White House National Economic Council (the position now held by Dr. Lawrence Summers). I wrote a series of posts on the auto loans beginning when the President made his late-March announcements, and continuing into the spring. For reference, here are those posts:

This morning I posted some basic facts on the General Motors announcement. Now it’s time for some analysis. Like my post Understanding the President’s CAFE announcement, this is a monster post. I hope you find it valuable despite its length.

I want to try to tease apart the various questions that get conflated in the public forum. My primary goal is to give you a structure for thinking about the issue. My secondary goal is to persuade you to agree with my views on each question. I will be satisfied if you give me credit for achieving only the primary goal.

Here is how I tease apart the questions:

What are the arguments for further government intervention?
Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?
Is the pre-packaged bankruptcy likely to succeed?
Is it fair?
Did the government structure the taxpayer financing correctly?
Will the Administration run GM?

Let’s take them one-by-one.

1. What are the arguments for further government intervention?

Today the President explained why he chose to put another $30.1 B of taxpayer funds at risk to prevent GM from liquidating now. Speaking about his decision on March 30th, he said today:

But I also recognized the importance of a viable auto industry to the well-being of families and communities across our industrial Midwest and across the United States. In the midst of a deep recession and financial crisis, the collapse of these companies would have been devastating for countless Americans, and done enormous damage to our economy — beyond the auto industry. It was also clear that if GM and Chrysler remade and retooled themselves for the 21st century, it would be good for American workers, good for American manufacturing, and good for America’s economy.

This is more expansive than what President Bush argued last December:

In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action. The question is how we can best give it a chance to succeed. Some argue the wisest path is to allow the auto companies to reorganize through Chapter 11 provisions of our bankruptcy laws — and provide federal loans to keep them operating while they try to restructure under the supervision of a bankruptcy court. But given the current state of the auto industry and the economy, Chapter 11 is unlikely to work for American automakers at this time.

The distinction is important. President Bush’s arguments were time-dependent: (a) we should try to prevent our weak economy from taking another big hit right now, and (b) let’s buy GM and Chrysler time to get ready to restructure. He also argued (c) that it was unfair to dump a liquidating auto industry on his successor (even if his successor might do something different than he would). It was a “too big to fail now” argument.

Today President Obama made it clear that he made the decision to commit additional funds, if his conditions were met, at the end of March. He then added new reasons to those expressed by President Bush: that America needs “a viable auto industry,” and that it would be good for America if GM and Chrysler survived. While he emphasizes what he would not do, “I refused to let these companies become permanent wards of the state,” President Obama defines a national interest in having auto manufacturers headquartered in the U.S. He reinforced that with his closing line, which was surreal:

And when that happens, we can truly say that what is good for General Motors and all who work there is good for the United States of America.

This is a big expansion of the justification for government intervention in the market. Ford is not failing, and Chrysler is emerging from bankruptcy. President Obama is arguing that American taxpayers need to fund the survival of a third (the biggest) U.S.-based auto manufacturer, because it is important “to the well-being of families and communities across our industrial Midwest and across the United States” and because “it would be good for American workers, good for American manufacturing, and good for America’s economy.” This argument could be extended to almost any large U.S. firm, at almost any time.

My view: I am extremely uncomfortable with the President’s expanded argument for further government intervention. Had the President instead argued, “The economy is beginning to recover, and we cannot jeopardize that with another major shock,” I would have been less uncomfortable with today’s commitment of additional taxpayer funds.

2. Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?

The public debate has evolved in the past two months. Earlier this year the question posed was, “Should the Administration bail out GM?” The basic options were “yes,” “no,” and “only if they enter bankruptcy, and if they do they should try to pre-package it.” The President chose the last of these options. The President decided to put $30.1 B of additional taxpayer funding at risk to help prevent GM from liquidating in the near future, and to help them through a restructuring process.

The benefits and costs are similar to what I described in late March. Here’s the updated version:

Benefits

If the firm survives the bankruptcy process intact, it has a higher probability of being viable in the long run (than in a restructuring outside of bankruptcy).
If the firm survives restructuring, the taxpayer has a higher probability of being repaid.
Old equity holders faced the full costs of the firm’s failure (by being wiped out). No additional moral hazard is created.

Costs

There are still significant risks to GM’s survival:
- Will GM and the Administration defeat the objecting unsecured creditors in court? (however unfair that might be)
- Will the bankruptcy process conclude quickly (within 90 days)?
- Will GM continue to lose market share? Can GM make cars and trucks that people want to buy?
- Will the new fuel economy and emissions rules restrict GM’s ability to make attractive vehicles?
This is a big new cash outlay from the taxpayer. This costs the taxpayer, and further constrains available TARP funds.

The President made clear his answer to this question on March 30th. At that time he laid out the conditions under which he would provide additional funding, and those conditions were met. No one should be surprised that he is now putting more taxpayer funding at risk. I am surprised that they only need $30 B.

My view: We crossed this bridge back in late March. It is not a new decision today to put more taxpayer funding at risk. I don’t like it, but I am at least glad that some incentives have been restored: the firm has to go through a bankruptcy process, shareholders are wiped out, and management was fired. I remember arguments from last fall and earlier this year that GM should get more taxpayer dollars outside of a bankruptcy process. That would have been far worse, and today’s actions mitigate some moral hazard.

Given the relative strength of the U.S. economy now compared to last December, I would have preferred an outcome of a pre-packaged bankruptcy + private DIP financing, and not exposing taxpayers to any additional risk. If GM is really as viable as GM and the President claim it now is, then they should have no problem convincing capital markets to provide them with short-term financing. (Judge Richard Posner argues this.) I will guess that this was not actually a viable option, because the pre-packaging could only come together with the direct involvement of the government. I think the real options would have been expose taxpayers to $30B more risk, or allow GM to liquidate. I would go with the latter: if GM can’t find private financing, they’re on their own. I assume this means they would liquidate. This would have been harsh and painful for those affected. I believe the consequences of further intervention now are worse for a larger number of people in the long run.

3. Is the pre-packaged bankruptcy likely to succeed?

There are two components to this question:

Is the bankruptcy process likely to be quick and successful?
Will the resulting company succeed without additional taxpayer aid?

I do not feel well-qualified to comment on the first question. The talking heads all repeat that “GM’s bankruptcy is more complicated than Chrysler’s,” with little detail about why. I would point out that the Administration is one for one in this process. Their use of this part of the bankruptcy code (section 363), and the process where the old GM sells the good stuff to a new GM, and then the remaining parts are liquidated, appears to have worked for Chrysler. From my perspective, the burden of proof now shifts to those who argue this bankruptcy will take more than 90 days. I didn’t like it because of the precedent it set, but I wouldn’t bet against the Administration succeeding again.

Other than the “good for GM is good for America” quote, the biggest surprise in the President’s remarks was how heavily he was betting that a restructured GM will succeed. He could easily have taken the posture, “GM has made some hard decisions, and they have a tough road ahead if they want to survive and succeed.” Instead, he attached his own credibility to GM’s future success and said:

So I’m confident that the steps I’m announcing today will mark the end of an old GM, and the beginning of a new GM; a new GM that can produce the high-quality, safe, and fuel-efficient cars of tomorrow; that can lead America towards an energy independent future; and that is once more a symbol of America’s success.

Even with a cleaned up balance sheet and more taxpayer funding, it is by no means certain that GM will survive for the long run. If GM fails in the next few years, the taxpayers will have lost an additional $30.1 B that the President committed today. In addition, the above quote will come back to haunt the President. I understand wanting to set a positive and optimistic tone. I am confused why he did so at such great political risk to himself.

I found it useful to return to my first post on the autos and review what this new pre-packaged bankruptcy + DIP financing does to the wide range of challenges faced by GM:

Revenues

The economic slowdown means fewer vehicles are being purchased from all auto manufacturers, foreign and domestic.

Even apart from the economic slowdown, U.S. auto manufacturers have been losing market share over time.

This is in part because they made a bet on light trucks versus smaller cars. This product mix doesn’t work when gas prices are high. Think of the proliferation of SUV’s in the past 10 years. (Note that this was in part the fault of U.S. government policies. SUV’s are technically light trucks, and so they qualify for lower fuel economy requirements.)

Costs & productivity

The Detroit 3’s ongoing labor costs are higher than those of foreign-based firms. This is still true when you compare an American worker in a GM plant in Michigan, for instance, with an American worker in a Nissan plant in Mississippi.

Productivity is lower in U.S. plants of U.S. firms than it is in U.S. plants of foreign-based firms. Some of this is because of the UAW contract that mandates certain inefficiencies. Some of it is poor management.

The Detroit 3 have huge dealer networks that are costly to the manufacturers. These dealer franchises are often protected by state laws that make it hard for the manufacturers to make these networks smaller and more efficient.

Auto manufacturers face a burdensome and unpredictable legislative and regulatory environment.

Balance sheets

The Detroit 3 have enormous legacy costs from their retirees. Past UAW contracts provided generous benefits that continue to burden these firms. This drains profits (when they earn them) away from productivity-enhancing investments.

So can GM survive, and for how long? Can they profit and flourish, as the President suggests they will?

The Administration and GM argue that a restructured GM can break even in a national market of only 10m vehicles sold in America each year. (We’re now around 9.5m/year. “Normal” is around 16m/year.) If accurate, this is astonishing. This would appear to address all three of the bullets under revenues. Addressed? I’m skeptical. I need to review the assumptions in GM’s new plan, especially about market share.
I have seen no evidence that GM and UAW have reduced significantly GM’s ongoing labor costs to be competitive with the transplants. Maybe I have missed it. Unaddressed.
Productivity is still lower in U.S. plants of U.S. firms that it is in U.S. plants of foreign-based firms. As a result of high compensation costs per worker and low productivity, it appears that labor cost per vehicle produced will still be uncompetitive with the transplants. Unaddressed.
GM’s dealer network is being dramatically reduced. Addressed.
The CAFE and emissions requirements are even more burdensome than predicted, but now have at least some degree of stability, given the national standards. On net, worse than before.
The balance sheets will be relieved of enormous debt and legacy health and pension obligations. Addressed.

My view: I need to look more at what GM is assuming for market share. The removal of the legacy obligations, combined with a big chunk of taxpayer change, will buy then many months of survival.

The Administration is stressing the balance sheet improvements, and they deserve credit for that. Conservative critics focus on the additional burdens of the fuel economy and emissions rules, and they’re right, too.

I would focus even more on the questions asked by several commenters: “Will people want to buy GM cars and trucks?” Additionally, can GM make a profit with still high labor costs, still low productivity, still burdensome work rules, and still slow product development cycles?

I want to GM to survive and be profitable in the long run. Their chances are now drastically improved, assuming they survive bankruptcy. But I don’t know if that’s an improvement from a 1% chance to a 20% chance, or from a 1% chance to an 80% chance. A lot more needs to change beyond just cleaning up the balance sheet, and many of those needed changes are deep-seated in the culture, structures, and processes of America’s third-largest company.

4. Is the pre-packaged bankruptcy fair?

Absolutely not. But I want to be precise in my criticism.

The easiest thing to do in Washington is to criticize the negotiator. “I could have gotten a better deal,” we say. I should begin my expressing my sympathy and offering my congratulations to Steven Rattner and the Obama team for closing what was undoubtedly a complex and difficult set of negotiations. I’m sure this one was not easy, and theirs was a thankless task.

At the same time, I share the concerns of many that the deal was not even-handed, and that the precedent will damage future business lending. I have grave concerns about how far they were willing to stretch bankruptcy processes and the traditional capital structure to get a deal.

First I need to correct the Administration, as well as some bad reporting today by the Washington Post. In last night’s background briefing for the press, an unnamed Senior Administration Official claimed (emphasis added):

Secondly, as you know, the UAW has reached a new agreement with GM and that agreement has been ratified that involves significant concessions by the UAW — concessions that are in virtually every respect more aggressive than what the previous administration demanded in its loan agreement.

In the term sheet for the December loan we (the Bush Administration) made to General Motors, we set out “targets,” which we took directly from the Corker amendment offered the week prior on the Senate floor:

Reduce outstanding unsecured debt by not less than 2/3 through conversion into equity or other debt;
“Reduce the total amount of compensation, including wages and benefits, paid to their U.S. employees so that, by no later than December 31, 2009, the average of such total amount, per hour and per person, is an amount that is competitive with the average total amount of such compensation, as certified by the Secretary of Labor, paid per hour and per person to employees of Nissan Motor Company, Toyota Motor Corporation, or American Honda Motor Company whose site of employment is in the United States.”
Eliminate the jobs bank.
Apply work rules no later than 12/31/09 “in a manner that is competitive with Nissan … Toyota or Honda in the U.S.”
Not less than half of their VEBA payment should be in the form of stock.

As best I can tell:

They more than accomplished target #1.
They did little to nothing on #2. I have seen no evidence that compensation of current workers has been changed. UAW Chief Ron Gettelfinger claimed in a message to his members, “For our active members these tentative changes mean no loss in your base hourly pay, no reduction in your health care, and no reduction in pensions.” Maybe there’s a distinction between this statement and “total compensation.” If so, it would be great if someone could help me understand this. But it appears GM and UAW did nothing to address target #2.
UAW agreed to #3 in late March.
They made no apparent progress on target #4. I have neither seen nor heard evidence that the work rules have been relaxed. I am happy to be corrected.
They accomplished #5.

It was incorrect for the Senior Administration Official to call these “demands” of the Bush Administration. They were targets, not hard conditions. It is an overstatement to say that they “are in virtually every respect more aggressive than what the previous Administration demanded,” unless “virtually every respect” means “except for compensation and work rules.” (I am happy to be corrected if I have just missed the changes.)

The Washington Post then further flubbed it by writing:

Critics say it is unfair that the restructuring plan gives the union health trust a larger share of the new GM than the bondholders. But administration officials defend the plan, offering several justifications.

First, they note that the terms of the proposed GM restructuring echo the terms laid out by the Bush administration in December, when it extended $13.4 billion in loans to GM.

The Bush administration’s loan agreement required a 50 percent reduction or “haircut” for the union trust, but a 66 percent cut for the bondholders. The Obama deal requires larger cuts for both sides, though more for the bondholders.

The agreement does more than meet three of the five targets laid out by the Administration. It appears to make no progress on the other two targets. Thus the terms do not “echo the terms laid out by the Bush administration in December.”

More importantly, the targets we (Bush team) laid out said nothing about the distribution of equity shares. The criticism is not that the deal doesn’t cut the VEBA enough, or reduce unsecured debt enough. The criticism is that someone lower in the capital structure (UAW’s VEBA) got a much greater equity share than someone higher in the structure (unsecured creditors). It is disingenuous to point to the targets in the Bush Administration’s December loans to justify this inequity.

The deal is unfair to unsecured creditors, because they get a worse deal than someone standing behind them in line (the UAW’s VEBA). It has nothing to do with who those parties are (labor vs. creditors). It is about the importance of maintaining a stable and predictable set of rules to govern the capital structure of a firm, and the value that stability creates for firms’ ability to raise capital. All these arguments boil down to the cardinal rule of waiting in line for the kindergarten bus: it’s not fair to cut in line. If that rule is broken too often, chaos ensues.

The Administration could be arguing, “Sure it’s unfair, but UAW had more leverage on us than the creditors, so we struck the best deal that we could. We needed UAW to sign onto the deal, while we thought we could roll the creditors in court.” This would better justify the disproportionate equity shares than claiming, “This is a fair deal.”

The objecting creditors will now defend their rights in court. If the Chrysler precedent is an example, you should bet against them. It is interesting that the President did not attack them as “speculators” this time, so at least the rhetorical leverage against them is weakened.

My view: I am more concerned with the signals this unfair treatment sends to future investors. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain firms. I wish I knew whether a different prepackaging was possible, one which would have maintained the precedence of the capital structure and did not stretch the bankruptcy process again. Unfortunately, it is impossible to know.

5. Did the government structure the taxpayer financing correctly?

Judge Richard Posner argues the government should have provided a loan rather than taken an equity stake in GM. The President suggested one reason why they preferred an equity stake: a loan would further burden GM with a stream of near-term interest payments to the government.

I think Judge Posner strikes a nerve with his suggestion. It seems that much of the public discomfort comes from the government now being the owner of GM. It’s the 60% number that made me gasp. It highlights a tradeoff between two goals on which conservatives focus: value for the taxpayer, and avoiding government interference and control. There is a tradeoff between the two.

I believe the U.S. government could auction its equity shares late this year and divest itself completely from General Motors. This would solve the government ownership problem. In doing so, I presume that taxpayers would recoup far less than the $30 B of cash provided.

Question for conservatives: How much of a loss are you willing to take on the $30 B to get the U.S. government out of GM quickly?

My view: I assume there is a non-trivial chance that GM may still fail in the next several years. I like the President’s and his team’s strong language today that this $30 B is the last taxpayer aid, but I would like to reinforce that by ending the government’s ongoing involvement in GM as quickly as possible. I am willing to sacrifice a significant portion of the $30 B to achieve that goal. I therefore recommend that, if GM emerges from bankruptcy, the Administration then establish a much more rapid timetable for selling its equity stake, even if that means the taxpayer loses much of the $30 B. Get us out of GM before the end of 2010. This will strengthen the bulwark against providing additional taxpayer funds if GM fails again.

Note:

Under current law, the authority to provide any firm with additional TARP funding expires December 31, 2009. Correction: Secretary Geithner can, after notifying Congress, extend the TARP authorities to October 3, 2010.
The “set a timeline” argument has direct parallels to a certain national security debate…

6. Will the Administration run GM?

Here I give the Administration credit for good intent and good initial execution. I take at face value the President’s statement that he does not want to run or control GM, and I give him points for saying so explicitly. I am sure there are others, including some in his Administration and some on Capitol Hill, that would love to run GM as Government Motors. I will trust the President when he says he is not one of those people.

I further give the Administration credit for the “Principles for Managing Ownership Stake” they released in today’s fact sheet. While they are being released in the specific context of the U.S. government’s new equity stake in GM, the White House writes more generally “(T)he Obama Administration has established four core principles that will guide the government’s management of ownership interests in private firms.”

The government has no desire to own equity stakes in companies any longer than necessary, and will seek to dispose of its ownership interests as soon as practicable. Our goal is to promote strong and viable companies that can quickly be profitable and contribute to economic growth and jobs without government involvement.

In exceptional cases where the U.S. government feels it is necessary to respond to a company’s request for substantial assistance, the government will reserve the right to set upfront conditions to protect taxpayers, promote financial stability and encourage growth. When necessary, these conditions may include restructurings similar to that now underway at GM as well as changes to ensure a strong board of directors that selects management with a sound long-term vision to restore their companies to profitability and to end the need for government support as quickly as is practically feasible.

After any up-front conditions are in place, the government will protect the taxpayers’ investment by managing its ownership stake in a hands-off, commercial manner. The government will not interfere with or exert control over day-to-day company operations. No government employees will serve on the boards or be employed by these companies.

As a common shareholder, the government will only vote on core governance issues, including the selection of a company’s board of directors and major corporate events or transactions. While protecting taxpayer resources, the government intends to be extremely disciplined as to how it intends to use even these limited rights.

Given that I trust the President’s statements on this point, the risks here are unintended consequences, from within his own Administration and from the Congress. They are big risks, and these are dangerous waters. I hope the Administration treads carefully.

My view: Given the undesirable situation of government equity stakes in, and even controlling ownership of, firms like GM and AIG, as well as potentially Citigroup and other banks, these are good principles. They are also easy to monitor. It is interesting and good that the White House fact sheet says, “The [UAW’s] VEBA will have the right to select one independent director and will have no right to vote its shares or other governance rights.” (emphasis added)

I urge the President to:

Enshrine the principles from today’s fact sheet in the term sheets for the taxpayer investments in GM (and other firms). We did this last December in the GM and Chrysler term sheets. Tie yourself to the mast. This will give you an easy excuse later when someone pressures you to vote those shares in a way that conflicts with the taxpayer’s interest.
Set clear rules for Administration contacts with GM – it’s probably best to funnel all contacts through specific Treasury or NEC officials on the autos task force. No freelancing phone calls to the Administration-appointed directors or “informal chats” with them from White House staff, or from DOT, EPA, USTR, DOE, even State. Put a firewall around interactions with GM.
Come out hard and quickly against the first proposal from a Member of Congress to leverage the ownership stake for a non-taxpayer goal. Nip it in the bud, especially if the idea comes from a friend.

It’s easy to criticize a huge decision like the one made by the President today. I strongly disagree with where we are headed, and I am concerned with the precedent that this deal sets for capital investment in American firms. The alternative, however, is that you have to be willing to allow GM to fail. I would be willing to do so, and it is therefore easy for me to express my views. In summary, they are:

I am extremely uncomfortable with the President’s expanded argument for today’s government intervention.
My first choice would have been to push GM to get private DIP financing. Assuming that was infeasible, I would have recommended denying GM the DIP financing, even if that meant they would liquidate. The economy is sufficiently healthier now than it was last December that I would be willing to risk the additional shock. But I agree the President crossed this bridge at the end of March.
I would bet in favor of GM emerging from bankruptcy, and against them surviving as an intact firm for 5 years without additional taxpayer funding.
The pre-packaging deal was unfair to unsecured creditors, to the benefit of UAW retirees. The Administration loses credibility with me by trying to argue this was a fair deal. They would have been more credible if they had argued it was the only deal they could get. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain U.S. firms.
If a loan rather than an equity purchase had been possible, I would have preferred that – I find Judge Posner’s arguments persuasive. Given the equity investment, I urge the Administration to divest as quickly as possible, even if it means a loss to the taxpayer.
Given the undesirable situation of the U.S. government owning GM and other large firms, the Administration’s new “Principles for Managing Ownership Stake” are solid. They need to lock them in, and corral or beat back all those people who work in the Executive Branch and Congress who have other goals in mind for GM and will be tempted to exert some leverage.

I thank you for making it through this extremely long post, and again want to thank all of the fantastic commenters. If you dislike the President’s announcement, I urge you to consider this question: Suppose the deal announced today were the only possible pre-packaged bankruptcy, and your choice was to take it or allow GM to liquidate now. What would you do?

Understanding the GM bankruptcy

© 2010 Keith Hennessey - Your guide to American economic policy

The Administration’s background briefing on GM

kbh — Mon, 01 Jun 2009 15:44:30 +0000

THE WHITE HOUSE

Office of the Press Secretary

_______________________________________________________________________________________

FOR IMMEDIATE RELEASE

June 1, 2009

BACKGROUND BRIEFING

BY SENIOR ADMINISTRATION OFFICIALS

ON THE GENERAL MOTORS RESTRUCTURING

May 31, 2009

Via Conference Call

7:10 P.M. EDT

MS. PSAKI: Thank you, everyone, for joining the call. Just a reminder that the call this evening is on background, and you can attribute quotes to a senior administration official. And the embargo is set for 10:00 p.m. this evening Eastern time. Everyone on this call should also have a fact sheet.

I’m going to turn it over to Robert Gibbs now.

MR. GIBBS: Thanks, everybody, for joining. We’re going to do this basically in two parts. The first part, my colleagues will go through the GM specific parts of the call tonight. And then after that we will go through the government ownership principles, which I know a number of you are interested in as part of this and other transactions.

So with that, I’m going to turn it over to my colleague.

SENIOR ADMINISTRATION OFFICIAL: Thanks, I’ll just try to run through this reasonably quickly and maximize the time for questions. Everyone should have a fact sheet. I know you’ve only had it for a short period of time, so let me run through quickly the main points that we wanted to cover.

Everyone is aware that 60 days ago the President announced that he would give General Motors 60 days in order to design a plan for viability that would achieve lasting and permanent profitability and opportunity for success. And since that time the company has been working diligently in conjunction with the auto task force to implement those principles, including one of the President’s main principles which was the concept of shared sacrifice among all of the stakeholders.

And so we are here tonight to give you a preview of the results of this, including what the President will talk about tomorrow. So I’ll run through that reasonably quickly.

First, within this concept of shared sacrifice there are several things to talk about — first, as I said, the auto task force has worked with GM on an operational restructuring that is designed to reduce General Motors break-even point of about 16 million annual rate of car sales down to 10 million annual car sales environment. As many of you undoubtedly know, we’re running about 9.5 million car sales at the moment. And so we hope that by reducing this break-even point GM will be able to endure a period of difficult car sales before hopefully we will see a recovery, and this will, of course, allow GM to become profitable at a much lower level of car sales than has been the case before.

Secondly, as you know, the UAW has reached a new agreement with GM and that agreement has been ratified that involves significant concessions by the UAW — concessions that are in virtually every respect more aggressive than what the previous administration demanded in its loan agreement. And one of the major aspects of that settlement, of that renegotiation, was changes in terms of the VEBA — employee retirement health care trust in which GM had a $20 billion obligation under its existing — and I’ll talk in a second about what’s going to happen with that.

GM is also announcing more or less as we speak that the steering committee has reported that bondholders represent at least 54 percent of GM’s unsecured bonds, have agreed to tender their portion of the $27 billion of unsecured debt for a pro rata share of 10 percent of the equity of new GM for — inaudible — for an additional 58 percent. And so I think from the standpoint of the U.S. government we are very pleased and gratified to be going into the 363 process that will commence tomorrow with such a strong showing of support from the — inaudible — community.

And then GM is also announcing tonight the specifics of its operational restructuring with respect to its plant operations. And we will leave the details of that to them as it is their decisions and their restructuring.

So we are going through, as I think everyone here is aware, a 363 process that we hope and expect will be similar to Chrysler. We do not expect it to be as speedy as Chrysler’s because GM is a far larger, far more complicated global company, but we do expect it to proceed, broadly speaking, along similar lines to the Chrysler one, which you all know, has made very good progress and is very close to a successful outcome.

So in the context of that 363, a new company, a new GM, if you will, will be formed to purchase the operating assets out of the old General Motors that will become part of this new company. And left behind in the old company will be liabilities and other miscellaneous assets that are no longer needed as part of the new General Motors that we expect to create.

So as part of that several other things will happen. First, the new GM will establish a new VEBA, a new independent trust. And you will recall that I mentioned the $20 billion obligation that the old General Motors had to VEBA. As part of the shared sacrifice that the President has emphasize, that will be replaced by a $2.5 billion note, $6.5 billion of preferred stock, and 17.5 percent of the equity of new GM — thus warrants to purchase an additional 2.5 percent of the company.

As was the case in Chrysler, VEBA will have the right to select one independent director, and as in the case with Chrysler, and will be the case with both companies, neither VEBA nor UAW will have any right to voter’s share or any other government right. So it is with the exception of one independent director, a purely passive interest.

As was the case with Chrysler, the qualified pension plan for both hourly and salaried employees will be carried over to the new GM and will remain intact and benefits will be paid in the normal course.

Thirdly, as I mentioned, the U.S. Treasury is preparing to provide about $30 billion of additional financing through — inaudible — possession process during this Chapter 11 to meet both working capital needs during the bankruptcy process as well as to refinance certain existing obligations, and as well as to be sure that the company has the means to be successful in the future. And I’ll talk a little bit more about that in a second.

The U.S. Treasury does not believe or anticipate that any additional assistance to GM will be required. We intend for this to be a permanent resolution of the GM situation and an abil

ity for the company to go forward and be profitable.

In exchange for the $30.1 billion, the U.S. government will receive about $9 billion of debt and preferred stock in the new GM and approximately 60 percent of the equity in the new company.

Let me emphasize in anticipation of those later discussion and questions that we did not seek or solicit or desire to have this equity position. We came upon it simply as a matter of prudence and out of desire to assure that GM was able to go forward with a flexible, deleverage balance sheet, one that is capable of sustaining itself during — in a very cyclical business in what is obviously a difficult environment. And so we had a choice as guardians of the taxpayer dollars, which was to either take this equity as part of the consideration that we could receive on behalf of the U.S. taxpayers, and hopefully have it result in the taxpayers receiving a greater recovery, or we could have simply left it behind and given it to others and taxpayers would have ended up much shorter in terms of the total outcome. So the equity ownership of the U.S. government is not something we sought or desired; it was simply a necessary outcome of the restructuring process and a desire to have GM with a substantially deleveraged balance sheet and able to be competitive.

We’re also very pleased to say that the governments of Canada and Ontario — similar to the situation with Chrysler, will participate alongside the Treasury by lending about $9.5 billion and they will also receive both debt and preferred stock and about 12 percent of the equity in the new GM, and similar to the case with Chrysler, the right to pick one of the initial directors.

I think at that point I will — I think I’ve covered now the main points on GM, so let me turn it back to Robert.

MR. GIBBS: Thanks. Before we take questions on that — do you want to go through our government ownership principles now? I know it’s a big part of what a lot of folks are interested in.

SENIOR ADMINISTRATION OFFICIAL: Sure, let me take that on and start by saying that while this, of course applies to GM right now, this is part of a much broader effort to articulate principles for the U.S. government investments in a series of other companies as well. So this is more about how we can expect the government to act as a common shareholder in this and other cases.

The first starting point is really to pick up on something you said, which is the government really has no desire to own equity stakes in companies any longer than is absolutely necessary and will actively seek to dispose its ownership interest as soon as it is practical to do that. The goal is to promote strong, viable companies that can become profitable quickly, can contribute to growth and jobs without government involvement. And there is absolute clarity about that.

Of course, in exceptional cases where the U.S. government feels it’s necessary to respond to a company’s request for assistance the government has decided to reserve the right to set upfront conditions that will protect taxpayers and promote the financial stability or encourage growth. And in the sense of — inaudible — conditions, there has been some — as you’ve seen in this restructuring and in some other companies, where necessary, these conditions are precisely the kinds of restructuring that my colleague has talked about and would focus primarily on ensuring a strong board of directors, that focuses on the right kind of management that can deliver a long-term vision, that gets these companies to be profitable, ends the need for government support as quickly as is practical.

Now, after those upfront conditions are in place, the government feels that it can protect taxpayers’ investment by managing its ownership stake as a hands-off in a commercial manner as possible. And so the government will not interfere with or exert control over day-to-day company operations and very much will ensure that no government employees will serve on board or be employed by the company it makes investments in.

As a shareholder, the government will limit what it votes on to core governance issues, particularly the selection of the company’s board of directors; major corporate events or transactions. And in its effort to protect taxpayers’ resources as much as possible, the government intends to be extremely disciplined as to how it uses even these limited rights.

So those, as I said, are the principles that apply here in the upfront restructuring of GM and in the intention of the government going forward, but are consistently being applied where the U.S. finds itself in these kinds of situations.

MS. PSAKI: Thank you so much. I think we’re ready to turn it over to questions at this point.

Q Good evening. Appreciating that this is obviously a bigger company than Chrysler, how quickly do you expect you can get it through, and do you expect that legally it will be more difficult?

SENIOR ADMINISTRATION OFFICIAL: In 60 to 90 days; more complicated and many more moving pieces, but we are hopeful that it will have a similar successful outcome.

Q Can you speak a little bit about the input that you will have on the selection of some of the directors — you’re not naming them directly, but you will have input into who some of the new board members are — what kind of direct or indirect input, and what would you be looking for in the directors?

SENIOR ADMINISTRATION OFFICIAL: Let me say a couple of things about that. First, you’ll recall that at the time the President, on March 30th — announced that a majority of the directors of new General Motors would be new, so by implication, there will be a number of existing General Motors directors that will continue with the new company and there will be identified, based on consultations between the current chairman and his colleagues and ourselves — there has been a process underway since that announcement, led by the General Motors board, to identify additional directors, again in consultation with the U.S. government.

Thirdly, with respect to the kinds of people that are being sought, they are business leaders, CEOs, former CEOS, people from other walks of life with relevant experience and can contribute, regardless of political background, affiliation, or nature. And I would point you to the selection of the term at Chrysler, Bob Kidder, very distinguished former businessman, former CEO of Borden, former CEO of Duracell, his politics are not known to any of us anyway, who has agreed to take this on because of his belief in this industry and belief and desire that Chrysler could succeed. And I think Bob Kidder exemplifies the type o

f individual that will be sought to serve on the new General Motors board.

Q Are we going to see the new board members named tomorrow or is that a longer process?

SENIOR ADMINISTRATION OFFICIAL: I would expect over the 60 to 90 days, by the time the company comes out of bankruptcy 60 or 90 days from now, I would expect you to see substantial additions to the GM board.

SENIOR ADMINISTRATION OFFICIAL: As a technical matter, these directors will actually join the board of New Co., which will be buying the assets out of General Motors.

Q Gentlemen, can you specify how the UAW negotiations altered the restructuring plan and are there still the number of plants being closed as before, even though there is one new assembly plant — also how would the process for — inaudible — dealer count of GM mirror or change from that used by Chrysler in its bankruptcy case?

SENIOR ADMINISTRATION OFFICIAL: We were involved in helping to facilitate the discussions between the UAW and General Motors, but I think those are matters that are best left to the two of them. I think the UAW has spoken about its contracts and what it believes. Obviously the vast majority of its members have ratified it. And General Motors has spoken about the contract. So I think they’re both satisfied with it and we’re satisfied with it, but we don’t see a need to get into the details.

SENIOR ADMINISTRATION OFFICIAL: And with respect to your second question, GM has already embarked on the beginnings of its new — inaudible — program. They have different management in process, so inevitably it thinks about life slightly differently and so it’s a slightly different process that they’re going through, but the goal and the end result is intended to be very similar.

Q Can you talk a little bit about how long it might take to get all this money back over time and what your expectations are as to how much the taxpayer might see back on this?

SENIOR ADMINISTRATION OFFICIAL: I don’t think we’re here today to predict or project. We designed the restructuring to maximize the potential for taxpayer money. The company has done a great job on the operational restructuring — in conjunction with our colleagues in order to facilitate that. And so we certainly intend to maximize taxpayer proceeds, but I would also point you back to what my colleague said, that we intend to also exit as soon as practical.

Q My question is to expand the subsidiary of GM. Australia, for instance, has got a subsidiary of General Motors America. What will happen to those subsidiaries, and will there be any restrictions on the new GM investing in factories overseas, like for instance, the factory in Australia?

SENIOR ADMINISTRATION OFFICIAL: One of the principles that the President established early on that we have very much intimated as part of this is that U.S. taxpayer dollars should stay within the U.S. And that is not intended to sound protectionist — I think it’s a principle that every country follows. And so we do not intend to use U.S. taxpayer dollars to support foreign subsidiaries. Happily, most of GM’s foreign subsidiaries are able to sustain themselves independently or by receiving support from their local governments, as I believe will be the case in Australia. We have had contacts with the Australian government on this matter and I believe they’re intending to support GM Australia.

You’re all aware of the restructuring of Opal — of GM Europe, and that was effected under the same set of principles, and those are the principles that we intend to maintain going forward. I think having a global footprint is certainly an advantage to General Motors, and to the extent that it is financially prudent and within those principles, we’d certainly like to see it continue.

Q Good evening. Could you give us a sense whether any members on the current GM board will be remaining on the board of the new company, and how that will work with the lead executives at GM, as well, please?

SENIOR ADMINISTRATION OFFICIAL: Well, I believe I already answered that question by reminding you that the President, on March 30th, said that the majority of the GM board will become new members, which means a minority will be old members. And so we do expect to have some continuity with respect to those members. Fritz Henderson is the CEO and like all CEOs, serves at the pleasure of the board, and we would expect that that relationship would continue.

Q As GM restructures and the government is now involved in that company, how — or will the government get involved in new jobs, or should I say, fuel-efficient, alternative-fuel sources, starting with that type of training with GM employees?

SENIOR ADMINISTRATION OFFICIAL: As my colleague suggested, there are a number of principles that are going to govern our behavior as a shareholder in this company and others, one of which is no involvement in day-to-day business matters. And that will be a continuing principle for us. Of course the government of the United States has many relationships with the automobile industry as a whole, including foreign companies and including companies that have not been the beneficiaries of financial support from the U.S. government. And those matters, whether they go to regulation for fuel efficiency, or regulation for safety or support, or employment or what have you, will continue, but they will continue on a track entirely separate from and not driven by our role as shareholders.

I might mention the President some time ago appointed Ed Montgomery, the former deputy secretary of labor, to support him in assuring that we were doing everything that we could for communities in Michigan.

Q I was just wondering if you guys are disclosing which plants or factories may close as part of all this restructuring. I know there’s been talk of 14, or is that still up in the air right now or haven’t been determined?

SENIOR ADMINISTRATION OFFICIAL: As I said earlier, General Motors I believe is in the process of releasing that information, and I think, in the context of what my colleague said about us not making plant-by-plant or any other kind of management decisions, we will leave that to them.

Q Thank you. I’ve got a couple of quick things. Are secured bondholders, do they get a hundred percent back? Does the tax lump carry forward, go to the new company? And can you say that there’s no negative impact on Ford from these arrangements that you’ve described? Thank you.

SENIOR ADMINISTRATION OFFICIAL: With respect to the first question, there are no secured bondholders in GM; there are secured banks, and they will receive a full recovery because they are amply secured, as distinct from the banks in Chrysler which were not fully secured.

With respect to your second question, I’m going to let my colleague answer — would you expect the transfer? And what was the third question? Oh, Ford.

SENIOR ADMINISTRATION OFFICIAL: Ford has ample financial resources. Ford has been very successful in maintaining and even growing its market share during this period and is a world-class company, and we do believe completely — and that has been the President’s decision — the belief that this country can support three domestic successful, viable auto companies.

Q Thanks, guys. A number of the principles — the governmental principles you’ve established — members of Congress have asked GM and the administration to keep the company from importing cars made in Chinese plants. Is that an issue that the administration will specifically stay away from, or will it take a position? Have you made a preference known to GM’s management?

SENIOR ADMINISTRATION OFFICIAL: GM has made a commitment in its later agreement with respect to production in North America. But as to any specific thing, no, that would be a kind of specific commercial thing and would not be the object of our negotiation with the company.

Q — any additional money going into GM beyond the $30.1 billion that you’re extending now — is that an expectation, or are you saying, or will the President say that this is it for GM, this is the extent of taxpayer money and they won’t get any additional funding?

SENIOR ADMINISTRATION OFFICIAL: There’s no plan of any kind, intention, contingency plan, anything of any kind for further support beyond this point.

Q But beyond not having as plan are you saying that there’s no way they will get –

SENIOR ADMINISTRATION OFFICIAL: We believe the support being provided within a framework on a conservative economic assumption should allow the company if stakeholders do what they need to do, if its managers are successful in doing what they need to do, to be commercially viable going forward and not require extraordinary support going forward. One never says never with respect to any hypothetical contingency that could arise in the future, but this is it for support for GM, and on a go forward basis, GM’s position will be the same as that of any other company in the United States.

SENIOR ADMINISTRATION OFFICIAL: We are reducing GM’s liability by well over 50 percent and providing it with the financial flexibility that we truly believe — and an enormous amount of work that’s been done here that will allow it to be viable even under today’s difficult economic circumstances.

Q I just wanted to ask what the sort of anticipated future of the whole task force operation that you all have set up is going to be? And maybe this answers that question, but whether there will be, six months from now or a year from now, some part of the U.S. government that will look after the shares that we will have in the two car companies, if only at a distance?

SENIOR ADMINISTRATION OFFICIAL: There are a number of people around the table who are looking at me with interest in how I answer this. On a go forward from here, moving through this bankruptcy where the government has a major role, there is a great deal to be done, and the staff of the task force will continue to be very active. The Cabinet members who comprise the task force will continue to play their role in providing expertise on a range of issues. On a go-forward basis, the government will obviously adjust its staffing to its needs. But for now, there’s plenty to do.

Q As it is now, you guys have folks in Detroit — I’m not sure what numbers there are. Is it anticipated that you’ll continue to have representation on site going forward?

SENIOR ADMINISTRATION OFFICIAL: We don’t have anybody in Detroit on any kind of long-term basis. People obviously go out there in the context of diligence. I think we — in the context of what my colleague said about the government as shareholder, we are shareholders, like a lot of other people who don’t control companies. And in that respect, we expect that the taxpayers will want us to monitor their investment and be sure that we understand what’s going on, but we’re not going to be having people based in Detroit or anything like that.

Q What will the government’s position be in terms of executive compensation issues?

SENIOR ADMINISTRATION OFFICIAL: There are a series of laws and other regulations that exist, and the company will comply with all of them.

Q But will you — you’ll have the ability to name the compensation committee. Will you leave it to the compensation committee? Will there be any government policy — because you have a policy with the banking bailout; I’m wondering if you’re going to have any kind of a policy for this industrial company.

SENIOR ADMINISTRATION OFFICIAL: Again, there are a series of policies; there’s the Dodd amendment, there will be regulations to implement the Dodd amendment in due course, and the company will live with them. We don’t intend to name the compensation committee per se. We intend to, as we said, to work with the company and their initial directors, but the compensation committee will operate on its own. And we assume, just as it has during the period of the loan agreements where there were also compensation restrictions, that it will operate within them.

SENIOR ADMINISTRATION OFFICIAL: And like as in any company, the board will name a compensation committee.

Q Thanks, guys. Just a couple quick questions. Can you talk about the appointment of the chief restructuring officer and about the bad assets that GM will leave behind, even if you’re not going to name the plants or the dealers that might be left behind? And also, is the government planning or encouraging any more management changes at GM?

0; SENIOR ADMINISTRATION OFFICIAL: I think those are all pretty much questions for the company in terms of the naming of the chief restructuring officer is a company decision. The assets that will be left behind will be — are being chosen, have been chosen by the company, and again we would direct you to them to answer those questions. And in terms of management changes, we have nothing further to announce on that at this time. As I said earlier, Fritz Henderson and other management key members serve at the pleasure of the board. It will be up to the existing board until emergence and then the new board to make any decisions about management.

MS. PSAKI: We have time for one more question.

Q I just wanted to go back to the question of the task force. In terms of the longevity of the task force, do you perceive it being needed well beyond the bankruptcy proceeding itself? I mean, do you perceive the task force being in existence in fact until the company is sold?

SENIOR ADMINISTRATION OFFICIAL: The company is not going to be — I mean, I’m not sure what you mean by the company being sold. The company will go through this restructuring period; new GM will emerge as part of the 363 process; and then the company will continue, as we said, as a private company operating in the for-profit commercial role and so forth. And the government, as we indicated, is a reluctant — will be a reluctant shareholder for only as long as is necessary, for as long as — we will be out as soon as is practicable. During that period of time, we imagine that the taxpayers want us to be looking after their money, and so as we indicated, there will be people here watching over that investment, but as I indicated, in the nature of passive shareholders similar to Fidelity or some other large investment firm that has a large stake in a company.

MS. PSAKI: Thank you, everyone, for joining the call. As a reminder, this is embargoed until 10:00 p.m. Eastern time.

END 7:40 P.M. EDT

###

The Smoot-Krugman carbon import tariff

kbh — Fri, 29 May 2009 18:44:55 +0000

I wrote last Friday about the China/India hole in the American climate strategy:

America appears to lack a high-probability strategy for how to get China, India, and Russia to agree to self-impose a significant positive carbon price.

The Administration and its Congressional allies are trying to impose a significant carbon price in the U.S. through something like the Waxman-Markey bill, while entering an international negotiation process in which as much as 60% of global carbon emissions could face little to no carbon price. The likely outcome would dramatically tilt the global economic playing field, harming U.S. workers and firms relative to their counterparts in China and India. At the same time, it would make little progress toward addressing the risk of severe global climate change, as a large portion of global carbon emissions would remain effectively uncapped.

In that post I identified two questions that American policymakers need to answer to fill that hole. The first of those was:

What tools should we use to try to convince the government of China to impose a positive carbon price as part of a global effort? (choose one or more)

Leadership: U.S. goes first and self-imposes a price. Then we use diplomacy to try to convince the Chinese to do the same.

Carrots: The U.S. pays the Chinese to reduce their emissions.

Sticks: The U.S. imposes import tariffs on Chinese goods as long as the government China does not impose a carbon price.

I now see that I was eight days behind Dr. Paul Krugman in identifying this challenge. On May 14th, he wrote in his New York Times column “Empire of Carbon”:

(T)he people I talk to are increasingly optimistic that Congress will soon establish a cap-and-trade system that limits emissions of greenhouse gases, with the limits growing steadily tighter over time. And once America acts, we can expect much of the world to follow our lead.

… But that still leaves the problem of China, where I have been for most of the last week. … But China cannot continue along its current path because the planet can’t handle the strain. … And the growth of emissions from China — already the world’s largest producer of carbon dioxide — is one main reason for this new pessimism.

I’d like to compare where I think Dr. Krugman stands on various elements of the strategic question I posed, and compare them with my own views. We differ in our concern about the risks and costs of severe climate change, and that difference leads us to radically different policy recommendations.

I should state at the outset my views on the science and risk of climate change. There is a significant amount of evidence that there is a long-term risk of severe climate change. But there is little discussion about the numbers: How big of a risk? How much warmer? How quickly? How certain are we? And the numbers matter a lot. If we knew with certainty that Earth would warm 10 degrees over the next 20-30 years, I would be screaming for an immediate big carbon tax. If instead we think Earth is likely to warm one degree over the next century or two, then climate change is a trivial concern and we needn’t worry about it. The problem is that nobody knows where we are between these two extremes. This uncertainty matters a lot, and it makes the problem hard.

Given this uncertainty, I believe there is a small but non-trivial risk that there will be severe climate change over the next century or two. And so I am willing to consider significant and effective policy actions to slow the growth of greenhouse gas emissions to reduce that risk. I do not, however, believe that risk is so great or so certain that we must immediately commit to drastic changes in our economy, or that we must ignore the costs of those policy actions. I treat this like any other policy question: Given tremendous quantitative uncertainty, what are the marginal costs and benefits of our current emissions path, compared with various recommended policy options? I will quantify my thinking on these questions in a separate post. I am willing to consider policies to set a domestic carbon price, if I can be convinced that they’re worth it and will work. So far I have not seen any carbon pricing proposal that I think (a) would have benefits that exceed the costs, and (b) is feasible in the real world of nation-states with differing national interests. But I’m open to suggestions.

For now, let’s focus on two different answers to the China/India question in the American climate strategy.

Dr. Krugman appears to believe that, if China does not slow its global greenhouse emissions growth, actions by the rest of the world will be insufficient to significantly slow global emissions. Krugman: “In January, China announced that it plans to continue its reliance on coal as its main energy source and that to feed its economic growth it will increase coal production 30 percent by 2015. That’s a decision that, all by itself, will swamp any emissions reductions elsewhere.” I agree with him on this point.
I agree with Dr. Krugman’s read of the official Chinese position: “So what is to be done about the China problem? Nothing, say the Chinese. Each time I raised the issue during my visit, I was met with outraged declarations that it was unfair to expect China to limit its use of fossil fuels.” This is consistent with what I know about the Chinese position from our Administration negotiators in 2007 and 2008 , and with what the Financial Times reported last Friday: “Beijing reiterated its belief that developing countries, including China, should curb emissions on a voluntary basis, and only if the cuts ‘accord with their national situations and sustainable development strategies.’” Translation: We’re not setting a domestic carbon price. The Chinese are proposing that the U.S. and other rich nations choose answer (B) Carrots from my menu above: rich countries pay China to reduce their emissions.
It appears that Dr. Krugman believes Chinese leaders will not be swayed by option (A) Leadership: “And once America acts, we can expect much of the world to follow our lead. But that still leaves the problem of China …” I largely agree with him on this point.
Dr. Krugman appears to presume that we must slow the growth of global greenhouse gas emissions starting now. I disagree with Dr. Krugman on this point, and am more persuaded by Dr. Bjorn Lomborg. The state of technology is such that economic costs of near-term emissions reductions are high, and the long-term climate benefits are small. As an example, Dr. Lomborg estimates that $1 expended through the Kyoto agreement would produce the equivalent of about 30 cents of long-term climate benefits. To the extent you believe long-term climate change must be addressed, we are better off devoting resources to technology pushes that try to reduce the cost of carbon-r
educing technologies. The less expensive these technologies, the easier it is for everyone to make significant emissions reductions, and the easier it would be to get a global emissions reduction agreement that includes China and India (presuming you think such an agreement is necessary).
Since Dr. Krugman believes that we must persuade the Chinese to change their growth path “because the planet can’t handle the strain,” he appears to conclude that we should threaten a carbon import tariff. His phrasing is quite careful, but he is clearly floating the idea:

As the United States and other advanced countries finally move to confront climate change, they will also be morally empowered to confront those nations that refuse to act. Sooner than most people think, countries that refuse to limit their greenhouse gas emissions will face sanctions, probably in the form of taxes on their exports. They will complain bitterly that this is protectionism, but so what? Globalization doesn’t do much good if the globe itself becomes unlivable.

Technically, Dr. Krugman does not say (1) the U.S. (2) should propose (3) a carbon import tariff. He instead predicts that “sanctions, probably in the form of taxes on their exports” will be imposed by unnamed countries “sooner than most people think.” By itself, this is only a prediction, But in the following two bolded sentences, he endorses such “sanctions, probably in the form of taxes on [Chinese] exports” by unnamed countries. With this clever phrasing, Dr. Krugman has floated an aggressive but ultimately deniable policy proposal: a carbon import tariff.
I believe there are cures that are worse than the disease. An import tariff would be protectionist (Dr. Krugman concedes this point). In the context of a global climate change negotiation in which different countries are establishing different domestic carbon prices, and in which two of the world’s largest economies (China and India) refuse to do the same, it is easy to see how a carbon import tariff by the U.S. could set off a global trade war, with potentially devastating effects on the world economy. It appears that Dr. Krugman is willing to bear the increased risk of a global trade war for the benefit of an increased probability that China (and India?) will slow their greenhouse gas emissions. I am not.

For completeness, my answer to my own strategic question is “(D) None of the above.”

Even if the U.S. establishes a domestic carbon price through a cap-and-trade or carbon tax, diplomacy alone will be unable to convince the Chinese and Indian leaders to do the same in their countries. Option (A) Diplomacy won’t work by itself.
Without reductions in Chinese and Indian emissions, I expect that the total climate benefits of the likely global reductions in future emissions growth would not be worth the economic costs to the U.S. of a domestic carbon price (in the near term).
I oppose the U.S. paying large developing countries like China and India to reduce their emissions. I am confident the U.S. Congress would agree with this view. Option (B) will not happen in the U.S., nor should it.
Because I think the risks of significant damage from severe climate change are small, and the costs of near-term emissions reductions using current technology are high, and because I am deeply concerned that a carbon import tariff might provoke a global trade war, I strongly oppose option (C) Sticks, including any form of carbon import tariff. Free trade, including with China, is more important to me than the possibility of creating leverage on Chinese leaders to try to change their energy development path.
We are not talking about small numbers here. China thinks developed countries should contribute 1/2 – 1 percent of GDP to help poorer countries cut their emissions, and the economic effects of domestic carbon prices are measured in the same orders of magnitude. When you’re measuring things in percent of GDP, you’re shooting with real bullets. I oppose imposing such a tariff, threatening one, or even floating the idea as Dr. Krugman has done.
Therefore, I conclude the best policy is for the U.S. not to impose a domestic carbon price in the near future. To the extent policymakers believe severe climate change is a risk that should be addressed, I instead recommend they focus on pushing carbon-reducing technology R&D, and reducing tariffs and other trade barriers to the exchange of such technologies, as Dan Price has recommended.
I would be comfortable with the U.S. contributing taxpayer funds to a joint international R&D effort, if it were an alternative to a domestic carbon price, and as long as U.S. firms maintained their property rights to such research.

I have tremendous respect for Dr. Krugman’s past work as an international economist. I am surprised that he is willing to risk a global trade war, and that he would apparently fire the first shot when the global economy is so weak.

CBO: Health IT and preventive care won’t save a lot of money

kbh — Wed, 22 Apr 2009 15:42:53 +0000

It looks like my post from yesterday agrees with CBO’s December paper. Maybe I should have read it earlier.

Yesterday I wrote,

Information must be combined with the incentive to purchase high-value medical care – a decision that involves both the medical benefit of the treatment and the financial cost. …

The Administration’s proposals on health information technology, electronic medical records, and medical outcomes research may improve health, but they will have little effect on slowing the growth of health care spending for those with low-deductible, low-copayment private health insurance. …

The Administration is giving an incomplete answer. They need to explain not just how much they will spend on health information technology, electronic medical records, and medical outcomes research, but how that information will be used to reduce cost growth, and by whom.

In December the Congressional Budget Office wrote,

Other approaches—such as the wider adoption of health information technology or greater use of preventive medical care—could improve people’s health but would probably generate either modest reductions in the overall costs of health care or increases in such spending within a 10-year budgetary time frame.

In many cases, the current health care system does not give doctors, hospitals, and other providers of health care incentives to control costs. Significantly reducing the level or slowing the growth of health care spending would require substantial changes in those incentives.

I am glad that I am in the same place as CBO on this point. Please consider this an ex-post footnote to yesterday’s post.

CBO: Health IT and preventive care won’t save a lot of money

© 2010 Keith Hennessey - Your guide to American economic policy

Slowing health cost growth requires information AND incentives

kbh — Tue, 21 Apr 2009 15:34:59 +0000

When I was growing up, I was taught that you change the oil in your car every 3,000 miles.

Suppose I take my three-year old car to Jiffy Lube for an oil change.

Jiffy Lube has all the latest information technology, as well as good data on both manufacturers’ recommendations and best practices.

After entering my license plate into their database and checking my odometer, the technician says, “Mr. Hennessey, it’s been only 3,000 miles since your last oil change. Your manufacturer recommends an oil change once every 12,000 miles. We have even better data based on comparing wear and tear on vehicles from all over the country, and we recommend once every 10,000 miles. Still, you have at least 7,000 miles to go before you need to change your oil.”

I argue, “But I thought you were supposed to change your oil every 3,000 miles?”

He replies, “Those were the old practices. We have better diagnostic technologies, better engines, and better oil. It’s now every 10,000 – 12,000 miles.”

I respond, “Thanks. How much does an oil change cost?”

Imagine if the technician were to say, “$50, but your insurance covers it. You only have to pay a $5 deductible.”

What would you do?

The President is absolutely right when he says, “We can’t allow the costs of health care to continue strangling our economy.”

The President’s budget director, Peter Orszag, is the lead Administration advocate for this policy. Director Orszag is right when he writes on his blog,

Now, many of you have heard me go on about how important it is to reform health care in order to bend the curve on long-term costs and get our nation on firmer fiscal footing – and this data shows how critical that effort is. When we say that health care is consuming too much of our GDP, we are not just citing an abstract statistic. These costs have real implications in sectors across our economy, limit our economic growth, reduce opportunities, and harden inequalities.

He then, however, argues,

This is why the Administration is making historic investments through the Recovery Act in efforts that will be crucial in bending the curve on the growth of health care costs while improving the health outcomes we can expect from our medical system. We are investing over $19 billion in health information technology to help computerize Americans’ health records, which will reduce medical errors and enhance the array of data that physicians and researchers have at their disposal. We are investing $1.1 billion in comparative effectiveness research, which will yield better understandings of which medical treatments work and which do not.

Additional information is good, but the example above shows why information by itself will not significantly slow the growth of medical care spending. Information must be combined with the incentive to purchase high-value medical care – a decision that involves both the medical benefit of the treatment and the financial cost. The government could use this information to reduce costs in health programs that it runs, like Medicare and Medicaid (I am certainly not endorsing that). But those of us with private health insurance are largely protected from the costs of the medical care we use because of the general prevalence of low deductibles and copayments. Even if we have better information, we may not care if the benefit of a particular medical treatment is small, as long as it seems really inexpensive. The Administration’s proposals on health information technology, electronic medical records, and medical outcomes research may improve health, but they will have little effect on slowing the growth of health care spending for those with low-deductible, low-copayment private health insurance.

I favor helping individuals get information so they can decide what is high-value for them. I imagine that those who favor a single-payor system would say those tradeoffs should be made for everyone by the government.

The Administration is giving an incomplete answer. They need to explain not just how much they will spend on health information technology, electronic medical records, and medical outcomes research, but how that information will be used to reduce cost growth, and by whom.

To be able to credibly claim that they will slow the growth of health spending, the Administration needs to answer the following questions:

Who will be empowered to make decisions based on this improved information?
Upon what basis will that decision-maker compare the costs and benefits of a particular medical treatment, good, or service?
How will you change policy to create incentives for that decision-maker to choose high value medical care?

Until they provide answers, they cannot legitimately claim to be slowing the growth of health spending in the private sector. They are just increasing government spending on technology.

Jim Capretta has discussed this in greater detail on his excellent blog, Diagnosis.

Slowing health cost growth requires information AND incentives

© 2010 Keith Hennessey - Your guide to American economic policy